1. Field of the Invention
The present invention relates to a method and an apparatus for facilitating transactions on a commercial network system and specifically a method and system for facilitating secondary trading of shares of an investment company such as an open-ended mutual fund or a hedge fund.
2. Discussion of Prior Art
An investment company pools money from shareholders and invests in a diversified portfolio of securities. Investment companies are generally known as mutual funds, hedge funds etc. According to the Investment Company Institute an estimated 66 million Americans invested a total of $4.49 trillion in mutual funds at the end of 1997.
An investor in a mutual find is a shareholder who buys shares of the find. Each share represents proportionate ownership in all the fund's underlying securities. The securities are selected by a professional investment advisor to meet the specific financial goals of the fund.
Fund managers typically invest in a variety of securities, seeking portfolio diversification. Mutual funds provide an economic way for the average investor to obtain the same kind of professional money management and diversification of investments that are available to large institutions and wealthy investors.
There are more than 6,700 mutual funds representing a wide variety of investment objectives. The selection of funds has increased over the years in order to meet consumer demand for fund products that help meet a variety of financial objectives.
Mutual funds are required by law to determine the price of their shares each business day. A fund's net asset value (NAV) per share is the current value of all the fund's assets, minus liabilities, divided by the total number of shares outstanding.
A fund's share price, or offering price, is its NAV per share plus any applicable front-end sales charge. The NAV must reflect the current market value of the fund's securities, as long as market quotations for those securities are readily available. Other assets should be priced at fair value, determined in good faith by a funds board of directors. The Investment Company Act of 1940 requires forward pricing i.e. shareholders purchasing or redeeming shares receive the next computed share price following the fund's receipt of the transaction order. Any expenses (including any fees) must be accrued through the date the share price is calculated. Changes in holdings and in the number of shares must be reflected no later than the first calculation of the share price on the next business day.
Mutual fund shares are easy to buy. Investors may purchase fund shares either through a broker, a dealer, a bank representative, insurance agent or directly from the fund. Investment professionals who provide services to investors are usually compensated for those services. This usually occurs through sales commissions, or through 12b-1 and/or service fees deducted form the fund's assets.
Direct-marketed funds are sold through the mail, by telephone, or at office locations. They typically offer funds shares to the public with low sales charge or none at all. Funds that do not charge a sales charge are known as "no-load" funds.
Mutual fund fees and expenses are divided into two areas i.e. transaction expenses and annual operating expenses. Shareholder transaction expenses are fees charged directly to the investor's account for a specific transaction. A front-end sales charge or "load" may be attached to the purchase of the mutual fund shares. This fee compensates a financial professional for his services. Under present law, this charge may not exceed 8.5% of the investment, although most funds charge less than the maximum.
A contingent deferred sales charge, imposed at the time of redemption, is an alternative way to compensate financial professionals for their services. This fee typically applies for the first few years of ownership and then disappears.
A redemption fee is another type of back-end charge for redeeming shares. It is expressed as a dollar amount or as a percentage of the redemption price.
An exchange fee is the fee that may be charged when transferring money from one fund to another within the same fund family.
An account maintenance fee is charged to maintain low-balance accounts.
Annual operating expenses reflect the normal costs of operating the fund. Unlike transaction fees, these expenses are not charged directly to an investor account, but are deducted from the fund's assets before earnings are distributed to shareholders. There are normally two kinds of operating expenses.
(1) Management fees, which are ongoing fees charged by the fund's investment advisor for managing the fund and selecting its portfolio of securities. PA0 (2) 12b-1 fees, which are deducted from the finds assets to pay marketing and advertising expenses, or, more commonly, to compensate sales professionals. Under present law, 12b-1 fees cannot exceed 1% of the fund's average net assets per year.
Mutual funds sometimes offer different classes of shares, such as Class A, Class B and Class C. Share classes represent ownership in the same mutual fund. The way an individual pays for the fund depends on the share class they own. This allows an investor to choose the sales charge that best suits their investment needs and preferences.
Class A shares generally have a front-end sales charge. Class B shares often have a 12b-1 fee and a deferred sales charge if they are sold before a certain number of years. Class C shares charge a higher 12b-1 fee but no front-end or back-end load.
The sale of mutual funds normally occurs the same way as purchases are accomplished. However, as noted above depending on the class of shares an investor holds, the price he receives will depend on the holding period and the back-end sales charge.
At present, mutual fund shares can only be sold (redeemed) back to the same mutual fund. If a mutual fund shareholder could find another investor who wished to purchase shares in the same mutual fund, the shareholder avoids the back-end charges and would receive more money than he would receive from redeeming the fund. The investor avoids upfront charges and would be able to buy the shares cheaper than he could from the mutual fund. This is a clear case of win-win for both the shareholder and the investor.
On the other hand, there are hedge funds that require an investor to commit his capital to the fund for a period ranging from one year to ten years. If for some unforeseen reason, an investor wanted to redeem his shares in the hedge fund before the lock out period ended, a secondary market would enable him to sell the shares to another investor and thus effectively bypass the restriction.
Secondary market trading is also applicable to derivatives on shares of investment companies. No derivatives on shares of investment companies exist at present because there is no secondary market in the shares of these investment companies. Therefore, the transaction cost of hedging these derivatives is prohibitive. The creation of a secondary market in shares of investment companies creates trading on derivatives of these shares as well.
Despite recent advances in computers and electronic network technology and the explosive growth in electronic commerce (e-commerce), applicant is not aware of a commercially viable secondary market in shares of investment companies such as mutual funds or hedge funds wherein buyers and sellers transfer shares of mutual funds to each other.
One element in achieving a viable e-commerce facility for transacting secondary market investment company shares is the ability to authenticate the identity of buyers and sellers. This is vital since the transfer of shares usually is fraught with fraud. Indeed, authentication systems have been developed to ensure the enforceability of electronic contracts. One such method is disclosed in U.S. Pat No. 5,191,613. That system utilizes, among other techniques, digital signatures to authenticate electronic contracts.
Moreover a secondary market for mutual funds which authenticates and binds sellers to the terms of their offers will be more likely to attract the attention of potential buyers, because they are assured of the legitimacy of the offer.
There is also a need for a third party to administer such a secondary market for mutual funds. The third party can administer an Internet site where sellers can advertise their shares for sale. Also, this third party can act as an agent for all the buyers and sellers and allow them to achieve pricing that was previously unattainable. Also, by maintaining a central site for the sale of shares, it makes it easy for buyers to search for offers to buy.
The applicant is unaware of the existence of any commercially viable secondary market for mutual funds, which contains the above features and addresses the above-described shortcomings in the prior art. Therefore, it is one object of the present invention to provide a method and a system for facilitating a secondary market for mutual funds that offers the capability for individual sellers to sell their shares at a higher price than they could redeem them and for buyers to buy those shares at a discount.
Another object of the present invention is to allow an intermediary to bind the seller to the terms of his offer.
Another object of the present invention is to allow an intermediary to bind the buyers to his purchase of the selected shares.
It is another object of the present invention for the intermediary to guarantee payment to the seller, with payment occurring on the settlement date and to guarantee delivery of the shares to the buyer on the settlement date.
It is yet another object of the present invention to allow either buyers or sellers to remain anonymous if they so wish.
A further object of the invention is to provide a system in which the identity of the buyer is authenticated along with the integrity of the buyer's purchase offer.
Another object of the invention is to provide a system in which the identity of the seller is authenticated in order to determine the seller's capacity to satisfy the conditions of his offer.
It is another object of the present invention to allow for purchases of shares that require more than one buyer to combine to fulfil the sales offer.
These and other objects of the invention will he apparent to those skilled in the art from the following detailed description of the invention, the accompanying drawings and the appended claims.